An attempt to explain in ordinary language the bizzare bazaar that is our financial system.

Tuesday, March 23, 2010

The DFSA Shows us its' War Face, it needs work but it's a start.

I have to be totally honest. When I first saw the news on Bloomberg that the DFSA had dissolved the board of Damas and taken action against the brothers Abdullah I engaged in not a small amount of triumphalism. After all I had been railing against these guys and the inaction of the regulatory authorities in my blog for months. Whenever I logged into Bloomberg right after checking the markets I would look up Damas news to see if there was anything I could write about.

When the news finally went across the tape, I felt vindicated. I felt as though my blog had played a role in bringing it about. By constantly harping on it and claiming that it would undermine the confidence of the markets in the DIFC and thereby damage the Dubai World restructuring I felt that perhaps I helped force the powers that be in Dubai to act. Having read the report of the DFSA I was especially vindicated in my decision to publish the tip I received on the true purpose of the Dubai Ventures vehicle. Of course the DFSA report contains many things on which I did not report so perhaps I didn’t have too much to do with it. I’ll console myself with the thought that somehow the 50,000 page views that my Damas articles have gotten over the past few months had at least some influence on the decision of the DFSA to act if not a decisive one.

The DFSA report itself reads like a spy novel with a surprise ending. It opens with a cast of characters and a list of weapons. First the villainous Brothers Abdullah and their tools of espionage and deception: the various legal entities, assets, and liabilities front companies and the like. Then there is our hero the DFSA with its’ virtuous arsenal outlined in the section entitled “Relevant Legislation and Rules.” When you get into the main body of the it has exciting chapters like “The 42.5 Million Transaction” or “The Gold Transaction” or, exotically unless you have been there, “The Sharjah Transaction.” Step by step, transaction by transaction you can see our hero stalking his prey. Layer by layer a truly astounding series of frauds are uncovered.

The brothers Abdullah siphon millions of dollars out of the company into their private accounts. When money is tight they conspire with Dubai Ventures to rig an IPO on the DIFX in order to swindle $170 million out of international investors which they promptly use a variety of means to steal. They use company funds to buy a building in their own name and then sell the building back to the company for a huge multiple of the original price and pocket the difference. Over two tons of gold go missing into the pockets of the Abdullah brothers never to be heard from again but are magically replaced from the company’s own stocks. Money is borrowed in the name of the company and paid out to the brothers. Land owned by the brothers is sold to the company for 46 million AED without any independent valuation. To the Brothers Abdullah Damas is a treasure house to be systematically looted, to the shareholders it is a house of mirrors: a mystery, wrapped in a riddle locked in an enigma.

But the DFSA is on the case. With every paragraph we can see our hero get closer and closer to the quarry. Stalking him, laying the trap, ready to spring... It’s like watching James Bond tailing a Evil Mastermind, through the labyrinthine streets of some ancient city. The Mastermind is so confident that he is above the law that he doesn’t even notice the agent stalking him. He brazenly goes about hatching and executing his evil plans little knowing that the Bond/TheDFSA are hot on is tail, watching, building the case, planning, waiting for the moment to strike.... Then, the moment comes. The Mastermind turns his back and Bond/DFSA springs into action, reaching into is coat pulling out his weapon and plunging it into the back of the villain... WHO BURSTS OUT LAUGHING BECAUSE OUR HERO HAS JUST SPENT MONTHS STALKING HIM IN ORDER TO STAB HIM WITH A SAFETY PIN.

I don’t want to admit it but that’s how the thing reads on the first pass. If you read the entire document the punishment does not seem at all to fit the crime. These guys stole 600 million AED or almost $170 million, the entire proceeds of the IPO not counting the fraudulent investment in the IPO from Dubai Holding. I’m sorry did I say steal? The DFSA calls them loans with non-commercial terms such as "without interest and with no fixed repayment date or schedule." Hmmmm... what is the difference between a gift with an option to repay and a loan with no obligation to repay? Or for that matter between having someone steal from you or borrow from you without asking or paying interest for an indefinite period? If you’re a shareholder, nothing.

The Abdullah Brothers borrowed/stole it using every kind of scheme and ruse imaginable and what does the DFSA do? It fines them $3million, $2.7 million of which is suspended indefinitely. So the bill due to them: $300,000. To put that in perspective if the Brothers Abdullah invested their ill gotten gains in 2 year T-Notes they would have earned their fine twice over in the time it took the DFSA to investigate their frauds, no problem DFSA. Heck, if you wait 18 months we can pay the whole $3 million back just with interest we earn on what we borrowed/stole. That is an awesome deal for the Brothers. So what do the shareholders get out of all this? The same deal the Brothers Abduallah negotiated with themselves and the Board which was recently fired. They promise to pay back all the money over time and if they don’t they agree to hand over their shares which are now worth vastly less than $170 million. Actually, try less than half that. Not such a great deal, it sounds like the Abduallah Brothers come out on top.

That’s one way to read it and that’s how it appears on the surface but, as with so many things in Dubai, you have to look a little bit past that to get the whole story. One of the things that the DFSA order does is compel the Brothers Abdullah to provide a list of all their assets both those they own free and clear and those which are encumbered in some way. It then places a lien on behalf of Damas on all these assets. Their original agreement with Damas gave them quite a bit of leeway as to whether and how they disposed of what assets they have with regard to repayment of the funds they withdrew from the company for their personal use. Now virtually all their assets are pledged to the undertaking, not simply their shares in Damas. Also the undertaking empowers the DFSA to seek additional legal action for the enforcement of this pledge in DIFC courts, decisions of which can then be handed to Dubai courts for enforcement.

On the surface this seems like a pretty weak judgement, and according to the letter compared with what one would expect in the United States it is a pretty weak judgement but it is important to remember the context. What this undertaking essentially does is economically destroy one of the most prominent business families in Dubai. It is important to remember what the financial position of the Abduallah Brothers most likely is. I joked earlier that if they invested their ill gotten gains in T-Notes they would earn back their fine every ten weeks or so. The truth is they did not invest in T-Notes, they invested in Dubai and other real estate projects right through the peak of the market. I would say it is a near certainty that they cannot afford to repay Damas, which they are obligated to do on a timeline and for which all their assets have now been pledged. Whether they are fined $300,000 or $30 million makes no real difference, they are going under because of the repayment clause. This is not over, the undertaking is the beginning not the end of the travails of the Abdullah Brothers. When they miss the first instalment of their payments to Damas we will see what the DFSA does to enforce this agreement, then we’ll know whether it has teeth or not.

I think there is another aspect of this that might not be obvious to a Western observer. The school of Sharia law practiced by the courts in the GCC does not necessarily have the concept of precedent. It is up to the judge to interpret the Koran and the Hadith according to the dictates of his own heart as he sees them in the circumstances presented to him. This makes it extremely difficult to obtain legal certainty and therefore Arab businesspeople will go to almost any length to stay out of court. In such a world, in order to have orderly commercial relations with other Arabs it is therefore essential to maintain a reputation for probity.

Such a reputation has real commercial value because if you have a reputation of dishonesty people won’t deal with you because they know they cannot enforce contracts against you. The Abdullah brothers were among the most prominent families in Dubai and the public exposure of their malfeasance, even if it was suspected before, will do real commercial damage to them. Even Mohammed Alabbar, probably the most prominent businessman in Dubai is caught up in the whole thing and has been forced from the Board.

Importantly, this undertaking fundamentally destroys the asset that was most important to the Abdullah brothers and the only thing that would enable them to recover: their good name. This sort of thing almost never happens in the middle east because the preservation of face is so important and many people consider it unIslamic to attack the reputation of another person. The fact that the powers that be in Dubai have allowed one of their most prominent members to be so publicly humiliated is, though perhaps small to Western eyes, a real step forward for the region.